Why Investors Should Run From This Value Trap


I gave up reading horror books back in the Goosebumps era. I'm just not into being frightened for fun. So it was a real challenge for me to work through RadioShack's (NYS: RSH) most recent 10Q -- the thing is absolutely horrifying. It's one thing to talk about the thing under the bed and a completely different thing to talk about the cost of running a failing business. I rarely agree with fellow Fool Michael Lewis, but this is one that we both dislike.

The gun on the wall
It takes all of four lines for RadioShack's income statement to go downhill. On line three, we see the company's gross profit of $360 million, then on the very next line SGA expenses of $363 million. Well, there that goes. By the end of the statement, the company has lost $21 million, or $0.21 per share. That's a far fall from last year, when RadioShack made $25 million in the second quarter.

Same-store sales were flat in the quarter, with the one bright spot being a 3% increase in mobile products. That was offset by a 27% drop in same-store consumer electronics sales, which does not bode well. Unsurprisingly, RadioShack suspended its dividend program in order to refinance some of its debt. Things are not looking good.

The rumor of a silver lining
RadioShack has done so poorly recently that it's starting to look like a bargain. The share price is under $3, while a year ago it was trading around $12. The stock is trading at a price-to-book ratio of 0.39 and a price-to-sales of only 0.06. Compare that to Target (NYS: TGT) , which is actually doing well these days, and trading at a price-to-book of 0.4 and 0.07 times sales. That kind of value can get people excited.

And there's some reason for the excitement. RadioShack is only valued at $290 million, making it a tasty-looking takeover target, if only for the stuff it has on hand. Even in a fire sale, with inventory deeply discounted, investors would seem to come out ahead. Potential buyers include Target, Best Buy (NYS: BBY) , and any number of private equity firms that think they could liquidate the company for a profit.

Best Buy could certainly use an avenue into smaller stores, and in fact it has already seen strong returns from its smaller mobile phone stores. Last quarter, domestic same-store mobile revenue increased 13%. The smaller RadioShack storefront could help Best Buy move away from its expensive, big-box design and help it get into new areas. RadioShack has 4,400 standalone stores in the U.S. and 1,500 Target Mobile centers.

That existing relationship gives Target an in, if it decides to make a bid for RadioShack. However, the standalone stores seem like less of a draw for Target, which has already established a smaller store model that's currently being rolled out and tested in specific centers across the U.S.

The cloud
There's a lot of weight to the argument that RadioShack is priced for death but could get picked up. Among other investors, RadioShack CFO Dorvin Lively just picked up 25,000 shares at $2.53 a share. That's not reason enough to jump in headfirst, but it certainly shows faith in something. It's safe to say that the faith isn't in the future of the company as a place to buy things, at least not as it exists right now.

RadioShack as a brand is almost nonexistent. The company competes with Best Buy and Amazon.com (NAS: AMZN) for customers. But whereas Amazon grew revenue 29% in its last quarter, RadioShack posted a measly 1% increase. It just can't seem to sell things anymore. In its earnings release, CEO Jim Gooch said, "Our business performed below expectations during the second quarter." That's a nice way of saying that the whole thing seems to be falling apart.

The bottom line
I see that RadioShack could be a buyout play, if that's the kind of bet that you like making. But for me, I can't imagine buying into a company that has no meaningful brand, no clear plan, and that has made no progress toward a turnaround. I have no desire to get behind RadioShack. I think that Amazon is a more interesting company with a much stronger brand. If the price is too high, then I'd look at Best Buy. With its stronger brand, and the recent interest from its founder, I think it's a much better play.

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The article Why Investors Should Run From This Value Trap originally appeared on Fool.com.

Fool contributor Andrew Marder does not own any of the stocks mentioned in this article. The Motley Fool owns shares of Amazon.com, RadioShack, and Best Buy. Motley Fool newsletter services have recommended buying shares of Amazon.com. The Motley Fool has a disclosure policy.We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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